Delayed but not dead, tax reform waits behind healthcare

As Washington settles into summer and the dog days fast approach, Americans might wonder what ever happened to the Inauguration Day exuberance over the prospect of tax reform.

Republicans dominating the White House and both houses of Congress promised to take aim at the U.S. tax code, particularly corporate tax rates that far exceed those of America’s key trading partners and international tax provisions that have driven U.S. business offshore. The stage seemed set for meaningful change in tax policy.

Yet half a year in, neither the House nor the Senate has a promising legislative proposal moving through committee. Like many of the campaign promises made by President Trump, tax reform is caught in a quagmire of complex change and political controversy.

“Everyone is waiting with bated breath,” says Jason Gerlis, regional director for North America at international services firm TMF Group. “We’re still in a holding pattern.”

The early days of the Trump administration have been characterized by heated debate over immigration policy, healthcare reform, international affairs, administrative appointments, even investigations—all pushing tax reform to the back burner for the first several months. Tax experts predict it won’t die there.

“I don’t think this is an area of rhetoric in the campaign that will be allowed to fall off the agenda,” says Gerlis. “Republicans hold the levers of power. The administration will not be allowed to forget what it has promised.”

The tax reform debate is informed by three major drivers:

The Trump proposal, scarce on detail, calls for a corporate tax rate of 15 percent, a territorial tax system that would tax domestic income but not foreign income, a one-time tax on trillions of dollars that U.S. companies are holding offshore to avoid U.S. corporate tax, and the elimination of tax breaks for special interests. It also reduces the number of individual income tax brackets from the current seven down to three, with a top rate of 35 percent.

The House Republican “blueprint” for reform, which predates the Trump proposal, advocates a 20-percent corporate tax rate and a destination-based cash-flow tax that would tax based on where goods are consumed rather than where they are sourced. The plan also calls for a border tax adjustment that would exempt exported goods but tax imported goods to discourage companies from offshoring their headquarters or operations. The House plan also flattens individual brackets from seven to three, but with a top rate of 33 percent.

A Senate plan, not yet committed to any kind of document, would digress from the border adjustment tax proposed in the House plan, but would seek to eliminate the double taxation that occurs particularly on pass-through entities, which are charged tax both at the corporate level and at the individual shareholder level.

“I don’t think this is an area of rhetoric in the campaign that will be allowed to fall off the agenda. Republicans hold the levers of power. The administration will not be allowed to forget what it has promised.”

Jason Gerlis, Regional Director, North America, TMF Group

The plans are far more complex than that, of course, with some bedrock principles in business taxation on the table. Should depreciation, or the writing down of asset values over time, be scrapped? Should deductions particularly for interest income, which theoretically drive investment in capital, be eliminated? Should income earned abroad be taxed? Should foreign-earned income brought back to the United States be free of tax? Should the estate tax be repealed once and for all?

Even before those big issues can be decided, agreement is necessary on whether the goal is to maintain funding or increase it. “Are we talking about revenue-neutral tax reform, or deficit-increasing tax reform?” says Jeff Kummer, director of tax policy at Deloitte Tax. “There are fundamental questions that key players have to decide.”

Dustin Stamper, a director in the national tax office at Grant Thornton, says the healthcare reform debate has affected how tax reform might roll out. “They learned a big lesson from how difficult healthcare reform has been,” he says. “They all do want to get on the same page and have member buy-in before they bring something to floor.”

Some say the complexity of it may be too much, even when there’s bipartisan and bicameral support for tax reform. “We’re hearing rumblings that instead of tax reform, we might be looking at tax cuts,” says Todd Simmens, national managing partner of tax risk management at BDO USA. “Robust tax reform is very expensive.”

Discussions in the halls of Congress and the White House are happening, says Al Liguori, managing director at consulting firm Alvarez & Marsal Taxand. “There seem to be meetings going on between members of the Legislature and the cabinet on what direction to take, but the public’s not getting much access to that,” he says. “Everyone is distracted by healthcare reform.”

2017 TAX REFORM PROPOSAL

Below is an excerpt from the White House memo on proposed 2017 Tax Reform for Economic Growth and American Jobs:

Repeal the 3.8% Obamacare tax that hits small businesses and investment income.

Business Reform

15% business tax rate

Territorial tax system to level the playing field for American companies

One-time tax on trillions of dollars held overseas

Eliminate tax breaks for special interests

Process:

Throughout the month of May, the Trump administration will hold listening sessions with stakeholders to receive their input and will continue working with the House and Senate to develop the details of a plan that provides massive tax relief, creates jobs, and makes America more competitive—and can pass both chambers.

Liguori is like many tax experts who believe broad tax reform is still possible, even likely, but will take longer than initially expected. He’s predicting details of proposals will start to emerge later in 2017, and legislative action will heat up in 2018.

“It’s possible for small pieces to happen in the fall, but the pressure will be on in 2018,” said Liguori. “Many legislators are going to be up for re-election, and they need to prove they can get something done. They won’t have a lot of time to do that in 2018.”

Kummer believes tax reform legislation could land on the President’s desk by the end of 2017, as Republicans in particular will want to make some meaningful achievements before heading into midterm elections in 2018. “I think it’s achievable because there is acknowledgement that the current system, particularly on the business side, is not competitive,” he says. “There is a desire to do tax reform in a way that generates direct, measurable GDP growth. Our corporate rate is far out of line with our trading partners, and our deferral is way out of step with our trading partners. But there are hurdles that have to be overcome.”

The remainder is summer is a critical time line that companies should watch, experts say. Congress recesses in August. If tax reform can gain some traction before then—at least in terms of some preliminary agreement on key principles—it stands a better chance of completion in 2017.

Tax planning, particularly for multinational entities, is a challenge in the meantime. Nothing feels certain enough to tax experts to suggest companies can rely on any particular change for planning purposes.

“In the deal space, stakeholders are not giving much credibility to the prospect of tax reform,” says Liguori, suggesting it’s not wise to count on reform, despite the optimism around it. “On the corporate strategic side, I see companies holding back on planning until the dust settles a little more. It’s holding up a lot of planning around operations. I definitely see companies hesitating, which is unfortunate because there are a lot of good business plans out there that should be followed through.”